The surging current account deficit in FY2022, driven by global inflation, has led to considerable public debate and debate over Bangladesh’s external debt situation and associated vulnerabilities. The unprecedented current account deficit has led to considerable pressure on the exchange rate, an increase in short-term borrowing and a depletion of foreign exchange reserves. Many see these developments as evidence of growing vulnerability in the balance of payments and external debt situation. There are also fears that scheduled loan repayments for a number of major infrastructure projects in the coming years will add to these pressures.
It’s a healthy debate, but it’s important that the discussions are based on solid data and evidence. Every effort should be made to avoid speculative analyzes that are not supported by evidence. This note aims to provide an analysis of the external debt situation and the underlying issues and challenges, with a view to clarifying the public debate on the facts of external debt and to assist the government’s thinking on how best to deal with it. move forward to stabilize the macroeconomy.
The evolution and current structure of external debt are shown in Table 1. Bangladesh has traditionally managed its external debt prudently. It has maintained a current account surplus or low deficit; it has relied heavily on low-cost medium- and long-term foreign borrowing financed by the state to fund its trade and investment needs; and recourse to short-term credit has been modest. Combined with a strong surge in RMG exports and labor exports, Bangladesh’s external debt indicators, both short and long term, have been comfortable.
The emergence of Covid-19 created some difficulties in the external sector due to the loss of export earnings, but the recovery happened quite quickly. In FY2021, the balance of payments and external debt indicators were all in the cautious zone. The long-term debt sustainability indicators (debt/GDP; debt/exports, debt service/exports) were all in the comfortable zone. The short-term vulnerability indicators (short-term lending to reserves and combined short-term lending plus current account deficit to reserves) were within prudential limits (well below 1).
The advent of global inflation fueled by the war in Ukraine since March 2022 has put severe pressure on the external sector of Bangladesh, which has resulted in the skyrocketing value of imports. Bangladesh’s exchange rate depreciated sharply as excess demand for foreign currency along with an appreciation of the US dollar in global markets pushed up the taka price of the dollar. Soaring imports pushed the current account deficit to an all-time high of $18.7 billion in fiscal year 2022. Financing this huge deficit required resorting to short-term borrowing as well as a significant loss of reserves.
The cumulative effect of these developments was a sharp deterioration in short-term debt indicators. The ratio of short-term debt to reserves has deteriorated from 30% to 50% between fiscal years 2021 and 2022, while the ratio of short-term debt and current account deficit to reserves has weakened considerably , rising from a low of 38% in FY2021 to a high of 94% in FY2022. Medium-to-long-term debt indicators remain in the comfortable zone, however.
How vulnerable is the current debt situation? From a medium to long-term perspective, there is no need to worry if exports remain stable. The simulations show that the medium- and long-term debt sustainability indicators remain within prudent limits. This is true even after taking into account the upcoming repayment schedule for a number of infrastructure projects, including the Rooppur nuclear power station (debt repayments of $569 million per year from FY 2027), the Padma Bridge Rail Link (debt repayments of $176 million per year starting in FY 2024), the Karnaphuli Tunnel (debt repayment of $53 million starting in the FY23) and the expansion and strengthening of the power grid in the DPDC area ($67 million per year starting in FY2025).
The short-term debt risk situation is delicate and could present a challenge. The sharp deterioration in short-term debt indicators in FY2022 noted above needs to be reversed and stabilized. If they remain within prudential standards (ratio below 1), given the uncertainties associated with the war in Ukraine and global inflation, Bangladesh would be well advised to protect its foreign exchange reserves against any further decline, while by seeking to reduce the current account deficit in the immediate short term (financial year 2023). This will require keeping the current account deficit at a level that can be fully financed by net MLT loans and net FDI flows, and short-term debt refinancing of $20.7 billion at a reasonable cost. . These in turn will require stabilizing the macroeconomy using a combination of monetary, fiscal and exchange rate policies.
The main policy reforms involve the unification of the exchange rate at the market determined rate with a single exchange rate for all transactions (exports, imports and remittances), the removal of subsidies on exports and remittances , removal of interest rate caps to reduce demand through interest rate adjustment, preparation for a major overhaul of the tax system to strengthen revenue mobilization, reform of public enterprises to eliminate government subsidies operating and earning a reasonable rate of return on invested assets, and increased spending on health, education and social protection.
Sadiq Ahmed is Vice President of the Bangladesh Policy Research Institute